Question

Mohave Corp. is considering eliminating a product from its Sand Trap line of beach umbrellas. This collection is aimed at people who spend time on the beach or have an outdoor patio near the beach. Two products, the Indigo and Verde umbrellas, have impressive sales. However, sales for the Azul model have been dismal.       

Mohave’s information related to the Sand Trap line is shown below.       

Segmented Income Statement for Mohave’s
Sand Trap Beach Umbrella Products
	Indigo			Verde			Azul				Total
Sales revenue	$	60,000		$	60,000		$	30,000			$	150,000
Variable costs		34,000			31,000			26,000				91,000
Contribution margin	$	26,000		$	29,000		$	4,000			$	59,000
Less: Direct Fixed costs		1,900			2,500			2,000				6,400
Segment margin	$	24,100		$	26,500		$	2,000			$	52,600
Common fixed costs*		17,840			17,840			8,920				44,600
Net operating income (loss)	$	6,260		$	8,660		$	(6,920	)		$	8,000

*Allocated based on total sales revenue

     
Mohave has determined that eliminating the Azul model would cause sales of the Indigo and Verde models to increase by 10 percent and 15 percent, respectively. Variable costs for these two models would increase proportionately. Although the direct fixed costs could be eliminated, the common fixed costs are unavoidable. The common fixed costs would be redistributed to the remaining two products.     

Required:
1-a. Complete the table given below, if Mohave Corp drops the Azul line. (Do not round intermediate calculations. Round Common Fixed Costs to the nearest whole dollar.)

  

1-b. Will Mohave’s net operating income increase or decrease if the Azul model is eliminated? By how much?

   

2. Should Mohave drop the Azul model?

	Yes
	No

     

3-a. Complete the table given below assuming that Mohave had no direct fixed overhead in its production information and the entire $51,000 of fixed cost was common fixed cost.

  

3-b. Should it the drop Azul model?

	No
	Yes

  

3-c. What is the increase or decrease in the net operating income of Mohave?

Answer 1

1

-a. Complete the table given below, if Mohave Corp drops the Azul line.

Segmented Income Statement for Mohave’s
Sand Trap Beach Umbrella Products
	Indigo	Verde	Total
Sales revenue	66000	69000	135000
Variable costs	37400	35650	73050
Contribution margin	28600	33350	61950
Less: Direct Fixed costs	1900	2500	4400
Segment margin	26700	30850	57550
Common fixed costs*	21804	22796	44600
Net operating income (loss)	4896	8054	12950

B-

Will Mohave’s net operating income increase or decrease if the Azul model is eliminated? By how much?

Yes, Mohave’s net operating income increase by $4950 (12950-8000) if the Azul model is eliminated

______________________________________________

2

Should Mohave drop the Azul model?

Yes

________________________________________

3-a.

Complete the table given below assuming that Mohave had no direct fixed overhead in its production information and the entire $51,000 of fixed cost was common fixed cost.

Contribution margin from Indigo (28600-26000)	2600
Contribution margin from Verde (33,350-29000)	4350
Contribution margin lost from AZUL	-4000
Net increse in contribution margin	2950
Chage in fixed cost	0
Net change in profit if AZUL is eliminated	2950

3-b. Should it the drop Azul model?

Answer: Yes

3-C

What is the increase or decrease in the net operating income of Mohave?
Change 2950 increase profit